Credit default swaps lead to hell

The key words are at the end of the video (below) are “ad infinitum.”

Credit default swaps (wikipedia article) sound like pretty abstract stuff, but it’s huge (>$60 trillion) and deadly. And when they start exploding they explode ad infinitum.

Unfortunately, none of the credit default swap risks are offsetting (since almost never done with the same counterparty). They are cumulative. The weakest player’s insolvency becomes everyone’s insolvency. The CDS infinite loop may be the unstoppable nuclear reaction that destroys all concepts of money, credit and trust that our economy, culture and society rest on.

It’s possible that the collapse in insurance company shares (MET, PRU, HIG) and certain banks (C) versus the relative stability of the Dow Industrials (green), reflect CDS risk.

And the fact that gold prices have been relatively stable for three months even as all other commodity prices tumbled also suggests an undercurrent of positioning for risk. At the edges, society is already starting to price for this instability. Cans of spam, shotguns and gold coins are in high demand. (Is there also a quiet run on penicillin and water filters?)

Sounds crazy, right? The collapse of a giant edifice of reason and rationalization is, by definition, crazy.

Untangling credit default swaps from Marketplace on Vimeo.

Also here’s an overview from This American Life.